GPM pressure remains with industry capacity and D&A hike
　　SMIC 1Q24 revenue and GPM beat mid-point guidance by 3% and 3.7ppts respectively, thanks to rush orders from smartphone and consumer electronics. 2Q24 guidance of 5-7% QoQ revenue growth and 9-11% GPM indicates the same message that demand is coming back but price cut is still key to winning orders for SMIC due to mature overcapacity within the industry. We expect a better market sentiment in 2H24 driven by new 14nm and 7nm capacity add at SMSC for domestic smartphone SoC and AI chips, despite that growing D&A and ASP pressure would keep weighing on near-term profitability. Eyeing on SMIC’s unique position as China’s advanced node fabs, we rate SMIC BUY but lower TP to HK$22.0 from HK$22.2 based on unchanged 1.1x P/B.
　　Key Factors for Rating
　　1Q24 financials beat: revenue increased by 20% YoY and 4% QoQ to US$1.75bn. GPM declined by 2.7ppts QoQ to 13.7% due to ASP pressure and heavy depreciation. Revenue and GPM both beat previous guidance thanks to rush orders from consumer electronics including smartphone, Bluetooth, WiFi and IoT. NI recorded US$72m, down -69% YoY.
　　2Q24 guidance in line: revenue guidance of +5-7% QoQ beat street by c.7% while GPM guidance of 9%-11% slightly miss street. We expect that while demand is coming back, price cut is still key to winning orders for SMIC due to mature overcapacity within the industry.
　　Order momentums last into 3Q24 while 4Q24 visibility is still low: rush order momentum should last into 3Q24 as multiple fabs of SMIC remain packed as of today while on-device AI, end of destocking and upcoming sports events should draw more new IC demands in coming quarters. However, management cautions on the medium-term demand sustainability given the weak macro while ASP is likely to see pressure as clients remain quiet price sensitive. We expect that key catalyst in 2H24 of SMIC is 14nm and below new capacity add, which is the current bottleneck for domestic AI and HPC IC fabless.
　　Key Risks for Rating
　　US-Sino relationship and supply risk; intensifying price competition in mature node; slow advanced node breakthrough; macro and end demand risks.
　　Valuation
　　We lower our 2024E/25E/26E EPS estimates by 30%/26%/10%, to factor in on- going ASP pressure in mature node foundry.
　　We slightly lower target price to HK$22.0 (was HK$22.0) based on 1.1x P/B (unchanged), roughly in line with its five year average multiple. We believe with SMIC’s breakthrough in advanced node, a clearer near-term roadmap of SMIC’s node migration and the bottoming out of the semiconductor market, the stock should enjoy a re-rate. Our target price represents 84x/40x/26x 2024E/25E/26E EPS. Maintain BUY.